Planning for your children’s education is very important, especially with tuition rates rising faster than inflation. Tuition is just one component of the cost of college. You may incur room and board expenses, books, meals, and parking. Some colleges even charge for internet access.
The cost for one year of tuition and fees varies widely among colleges. According to the College Board, the average cost of tuition and fees for the 2012–2013 school year was $29,056 at private colleges, $8,655 for state residents at public colleges, and $21,706 for out-of-state residents attending public universities.
Although the potential expense can seem daunting, don’t forget that college educations come at all levels of cost, and there are ways to help reduce the expense. Financial aid, grants, student loans are just a few – while there are also tax advantaged ways to begin saving for future college expenses, such as 529 Plans and Education Savings Accounts (“ESAs”).
Education Savings Accounts (ESAs)
The Coverdell Education Savings Account, also referred to as an ESA, allows children, the parents, grandparents and other relatives or friends to contribute up to $2,000 per child until the child’s 18th birthday (IRS income limits apply). There is no requirement that the depositor be related to the beneficiary child. Contributions are made “after-tax”, and grow within the plan. Distributions are tax free, as long as they are used to pay for IRS qualified higher education expenses prior to age 30. Unlike 529 Plans, qualified distributions can be used for elementary and secondary school education as well (K-12). A taxpayer can contribute to both an ESA and 529 Plan for the same beneficiary in the same year (however, specific income restrictions apply to eligibility to make an ESA contribution).
Named after the section of the IRS code, Section 529, these education savings plans are operated by either a state or an educational institution. Most plans allow you to invest in their plan whether you are a resident of their state or not. However, it is important to research any potential tax advantages that may be offered by the state plan where you reside. Contributions are made “after-tax”, and grow within the 529 plan account tax deferred. Distributions to pay the beneficiary’s qualified college costs come out federally tax free. Some states even offer additional state tax benefits (such as state tax deduction on contributions). Remember, you do not have to be a resident of a specific state to invest in that state’s 529 program. However, not every state offers additional incentives. Our financial advisors can help you research the most appropriate program for your personal situation.
It’s difficult to know just how much you should save, where it should be invested, and whether it makes sense to reduce retirement savings to build up your college fund. One thing that is certain, the earlier you start, the more you can take advantage of the opportunity to allow your savings to benefit from “compounding.” Compounding is the ability of an investment to generate earnings, which are then reinvested in order to generate their own earnings. For example, if you hypothetically invested $10,000 and earned 5% the first year, the following year you will have the potential to earn additional returns on the increased $10,500 value.
Your Cutter & Company Financial Advisor will help you put college planning in perspective as part of your overall financial picture, and show you how careful planning can help you pay for college without sacrificing your retirement or other major goals.